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At an English country mansion last month, lawyers for Royal Bank of Scotland (RBS) (RBS.L) sat down with representatives of angry shareholders to broker an end to what may end up being the costliest case in British legal history.

The meeting at The Grove, an 18-century estate near London that served as the secret World War Two HQ for Britain’s biggest railway company, was convened to persuade investors to drop claims they were misled into stumping up 12 billion pounds just a few months before the bank’s bailout in 2008.
But the low-profile gathering came to nought, an outcome that could have huge implications for Royal Bank of Scotland’s recovery as it risks adding up to 6 billion pounds to the lender’s litigation bill, lawyers said.

Once a small Scottish retail bank, RBS staged a meteoric rise to global prominence over two decades with an aggressive expansion that threatened to topple the UK financial system.
By early 2008, bad bets on toxic mortgage debt, increased loan defaults and a highly leveraged takeover spree had left RBS’s balance sheet in desperate need of capital, and management turned to investors for the ill-fated cash call.

More than 35,000 shareholders who took part, including some of Britain’s biggest institutional investors and public pension funds, allege RBS deliberately concealed the extent of its financial woes when it raised the money in April 2008.
The bank succumbed to a 45.5 billion pound bailout just six months later in October and has since failed to post an annual profit. The shares issued in the rights issue have lost nine-tenths of their value, and the investors who bought them now want to be compensated.

At the meeting at The Grove, RBS offered investors about 700 million pounds, according to two sources present, but the claimants reckon they should get 4 billion pounds in damages, plus another 2 billion in interest and legal fees.
“They are offering pennies when we are after pounds,” said one lawyer, who asked not to be named because the talks are confidential. “We are never going to meet in the middle. So we are now focused on pursuing the actions through the courts.”

TOO FAR APART
The next pre-trial hearing is scheduled for Sept. 8 at the High Court in London. Over the next few months lawyers on both sides will learn who will be called as witnesses.

Former RBS Chief Executive Fred Goodwin, who has shouldered the blame for the bank’s rapid demise from national treasure to national disgrace, is likely to be called, dealing another blow to the lender’s efforts to draw a line under its troubled past.
RBS, which is now 70 percent state owned, has always denied any wrongdoing and said its former bosses did not act illegally. “We continue to strongly defend these claims,” the bank said in a statement.

“We have always been clear that the bank is open to exploring an out of court resolution to matters, consistent with our legal obligations,” RBS said.
The bank flew in commercial dispute resolution specialists from the United States and New Zealand to mediate at The Grove, one of the sources said, demonstrating the lender’s desire to avoid a lengthy stint in court.

“We all thought we were going to get a deal,” said another source at the talks. “The strategies are going to evolve over the coming months, but I think the parties are too far apart to get a deal.”
Scheduled to begin in March, the case comes just as RBS is preparing to settle a record U.S. fine for mis-selling mortgage bonds before the crisis and shows how deeply the 2008 financial crisis haunts what was once the world’s biggest bank by assets.

The investor lawsuit says RBS made no mention in its prospectus for the cash call that its capital levels had fallen below the regulatory minimum; that the government had ordered the bank to raise the cash, or that RBS was already using $11.9 billion of “secret” loans from the U.S. Federal Reserve.

INFORMATION TRAIL
The first part of the trial to establish if RBS must compensate shareholders is scheduled to last six months. If it loses, another case may decide how much it must pay and lengthy appeals are expected, sources close to the matter said.

So far, RBS has been forced to disclose 25 million pieces of information, including private emails and other messages sent by senior executives at the time, to lawyers who are hoping to prove that management deliberately hid evidence of the bank’s deteriorating health before shareholders were tapped for cash.

The initial stage of the trial is expected to generate defence and prosecution fees of about 140 million pounds because of the number of claimants and the complexity of the case, according to four sources working on it.
If those estimates are correct, the case will become the most expensive in British legal history, exceeding the almost 100 million pounds of costs incurred during the News Corporation phone-hacking trial.

But some of the bank’s shareholders say the U.S.-style shareholder class action suit against RBS is counterproductive and will just delay the point at which the bank can return capital to shareholders by resuming dividend payments.

“Institutional investors suing themselves for the enrichment of the lawyers is bananas but it is what it is,” one shareholder, who declined to be named, told Reuters. “It chips away at the investment case, which is the return of surplus capital.”
“Analysts typically have a few billion for the Department of Justice (settlement) but they’ve not had much in for the shareholder litigation … you could be thinking, what surplus capital?” the investor said.

RBS CEO Ross McEwan has admitted he is worried about the damage the case could inflict on the bank’s battered reputation but he has also said he could not agree to a settlement that was unreasonable and is ready to fight if the case reaches court.

“We have to assess this from many angles. One of those is the public reputation but the other one is for our shareholders … we shouldn’t be signing up for something that we don’t think is fair,” he told reporters this month.
“It will be very public. But so be it.”